TAM-TAM: Hit the drums! Get your head around Total Addressable Market.
Just like a powerful overture when a symphonic orchestra start with base-drums at the back, to send shock and grab the attention of the suit & tie audience, the number crunching mind-trick behind Total Addressable Market metrics serves the same purpose.
When you open your business files the TAM question is likely to pop-up within a few minutes. By definition “TAM is the overall revenue opportunity for a product or service, given a 100% market share” an unlikely status in markets, an abstract figure. So what is the catch?
The Venture Capital and investment world is full of bets. An educated guess on which market, industry and company is more likely to succeed than the other. In the US the saying goes like “1 out of every 10 early stage investment is likely to succeed to balance and over-shine the loss of 9 others”. This figure recently climbed up to 1:15 or in the CEE region is even at 1:20. So the venture capitalists are betting on to find that 1 out of 10, which were selected from other 100 investment opportunities, to make or break their financial returns. An important guidance on how they analyze, compare and select companies, lies on the potential to tap into a large, growing and considerable Total Addressable Market.
The Top-Down Approach
This way of estimating the market size of your project is based on external and more likely macro-date to begin with. This is the most common approach when you have no track record and you need to collect all the inputs to justify your market from public data or from expensive market-reports.
The output of the research and answering the questions are an estimate based on 3-5 solid assumptions to make it look like more credible, like this: “The global market for pet medicine in 2020 worth $XXXbn, with a growth rate of X% annually. It is based on growing disposable income in welfare states, the growing proportion of what is spent on animal care, the increasing number of pets per households, and the growth rate of the past 10 years on average”
If you look closely every word has its significance:
- “The global market” – So you opt for competing on a global scale, which is ambitions. You might need to drill down to manageable sizes (see later)
- “Pet medicine” – the carefully chosen name for your industry you are in. If you are about to invent your very own industry, try to combine two related or associated sector for this purpose.
- “in 2020 worth $XXXbn” – The size of an industry usually refers to the total amount spent on the product or service within a given year. If we are talking about the global scale it is usually quotes in $, USD terms.
- “with a growth rate of X% annually” – It is important to give your venture a likely perspective to follow. Having an industry snapshot is important to get the absolute terms, but offering a bright future ahead can be crucially convincing.
Fire by words and back them up with data. Collect, verify and prove your assumptions with credible and reliable source of information.
- Assumption 1: “It is based on growing disposable income in welfare states”
- Assumption 2: “the growing proportion of what is spent on animal care”
- Assumption 3: “the increasing number of pets per households”
- Assumption 4 “the growth rate of the past 10 years on average”
These “rock-solid” assumptions are likely to support our idea to venture into the market as all the curated indicators imply a bright future ahead of us.
The bottom-up approach
This is the way to build up your potential market starting from within and expanding to the horizon. It helps if you have track record, which gives your initial number to start with like: “Out of 100 software companies 3 would pay $XXX,XXX for a service like mine at the moment” This way you can start building up your model by your geography, your segment or your industry, growing out the boundaries of your current situation. “There are more than 10,000 software companies in the region”
“if I can grow the proportion of companies willing to pay for my services form 3:100 to 5:100 and increase my fees by 5% from $XXX,XXX – then I can serve a market with $XXX,XXX,XXX”
Here, market surveys or focus group discussions could have great importance further strengthening your case. Expect to invest time & effort to bring insightful results, but the output will give you a competitive edge over vast, global datasets.
Differences between TAM, SAM, and SOM
TAM = Total Addressable Market, SAM = Serviceable Available Market, SOM = Serviceable Obtainable Market. TAM, SAM, and SOM represent the various subsets of a market. TAM refers to the total demand for a product or service that is calculated in annual revenue. SAM stands for Serviceable Available Market, and it is the target addressable market that is served by a company’s products or services. SOM, on the other hand, is an acronym for Serviceable Obtainable Market, which is the percentage of SAM that is realistically achieved. Identifying these subsets within an industry requires some market research to understand the proportions of each area.
It is essentially narrowing down your offering to a more manageable and realistic levels to handle market size.
So, which approach is better?
It depends of course. The top-down approach if done correctly could show macro trends and demonstrate a thorough understanding of what business you are in. If you can back your vision with bottom-up numbers, it is even better making your assumptions bulletproof. Breaking down the big size into smaller manageable segments helps you and your reader to better understand your chances of success.
Does size really matter? Yes!
Is there a case where a market size is too big or too small?
After narrowing down your number significantly and you still talk about billions, probably you failed to find a right market segment for your project. This is the case when you are attempting something unprecedented in human history or simply that there is no public or reliable data available to support your thinking. In this case you need to be creative to use proxy industries or competitive insights to frame your estimates within boundaries.
On the other hand, if you end up with a Total Addressable Market with only a few millions, you might have fall on the other side of the horse. You might have narrowed your estimated down excessively or pointed towards a niche market either by geography or segment. When you end up with too small numbers try to think more broadly about how and who can pay for your product or services.
Again, the TAM game is about to help investors to make a well-educated guess about their investment decisions so help them to find you more likely to succeed.